Trade Policy during the Interwar Period Judy Goldstein

Trade Policy during the Interwar Period Judy Goldstein Barry Weingast Michael Hiscox Lecture 8 – Thursday, 6 October 2011 J A Morrison 1

Lec 8: Interwar Trade Policy I. The Global Trade Regime before WWI II. The Interwar Collapse III. Reconstructing the Global Trade Regime IV. Conclusions & Further Questions 2

Lec 8: Interwar Trade Policy I. The Global Trade Regime before WWI II. The Interwar Collapse III. Reconstructing the Global Trade Regime IV. Conclusions & Further Questions 3

Here’s a very quick and dirty review of the trade regime before WWI. (Check Krasner for more details. ) 4

Pre-war Trade Regime • 1815 -1860: Britain moves towards free trade; sets trend and pace for other countries • 1860: Cobden-Chevalier Treaty – Britain brings arch rival France on board – Most-favored-nation clause • 1870 s-1914 – Rise of Germany; “Merkantilismus” as statebuilding (G Schmoller) – General continental retreat from free trade – British retain free trade unilaterally 5

World War I • Economic warfare during war (even in GB) • Shattered spirit of European cooperation • Accelerated British relative decline, not so good for imperial relations • Gave us Versailles (Oh joy. ) 6

Lec 8: Interwar Trade Policy I. The Global Trade Regime before WWI II. The Interwar Collapse • Reconstructing the Global Trade Regime • Conclusions & Further Questions 7

II. The Interwar Collapse 1. 2. 3. 4. Who will take the reigns of power? The US: Smoot-Hawley Britain: Imperial Preference The Axis: Self-Sufficiency

The War reflected and inspired a crisis of global economic leadership. 9

Hostilities had largely been a product of competition between competing visions and centers of power: GB, Germany, A-H, & the Turks. 10

Beginning in 1860, Japan wanted to be set on an equal footing with the Western powers. Japan wanted, at a minimum, regional hegemony in East Asia. 11

After the War, Britain sought to retake the reigns of power. But, as we’ll see, Britain was incapable of doing so. Too much had changed. 12

The United States had the capacity but not the desire to lead. 13

The crisis of leadership shaped the course of events that followed. 14

II. The Interwar Collapse 1. 2. • • Who will take the reigns of power? The US: Smoot-Hawley Britain: Imperial Preference The Axis: Self-Sufficiency

In the wake of the stock market collapse, the US felt compelled to respond. And the Smoot-Hawley tariff of 1930 was one of the most significant responses. 16

Smoot-Hawley Tariff • Became law: 17 June 1930 • Authors – Senate: Reed Smoot (RUT) – House: Willis Hawley (ROR) • Highest tariff rates of 20 th Century – Fordney-Mc. Cumber Tariff Source: http: //eh. net/encyclopedia/article/obrien. hawley-smoot. tariff 17

Smoot-Hawley: Effects • Triggered retaliation (particularly in Canada) • But what were the total effects? – Total Decline in Real GDP (1929 -1931): 16. 5% – Exports (1929 -1931): Max Decline 1. 7% of 1929 real GDP – Estimated Multiplier Effect (x 2) on GDP: 3. 4% – Portion of 16. 5% total decline caused by decrease in exports: 21% S-H lessened trade and deepened the Source: http: //eh. net/encyclopedia/article/obrien. hawley-smoot. tariff 18

And Smoot-Hawley, of course, has achieved legendary significance… 19

Ferris Bueller’s Day Off (1986). You. Tube 20

Al Gore & Ross Perot on Larry King (1993) - You. Tube 21

So, how do we explain the passage of Smoot-Hawley? 22

Eichengreen explains S-H using Gerschenkron’s model. How does Gerschenkron’s model work? 23

Gerschenkron on the “Marriage of Iron & Rye” • The case: Bismarckian Germany • Nuanced view of “Interest Groups” – Agriculture: Large (Junkers) & Small – Industry: Heavy & Light • Interest-Groups Model: Narrow, wellplaced groups compromise & form coalitions to secure compatible objectives • The Coalition: Heavy Industry + Large Agriculture 24

Eichengreen on Smoot-Hawley • Agriculture – Unsheltered: Border states compete with imports – Sheltered: Spoilage allows interior to be insulated • Industry – Heavy: US has comparative advantage in heavy industry – Light: Specialty goods face competition from abroad • The Coalition: Light Industry + Unsheltered 25

The United States turned its back on the world economy with Smoot-Hawley (among other things). . . 26

“Our international trade relations, though vastly important, are in point of time and necessity secondary to the establishment of a sound national economy. I favor as a practical policy the putting of first things first. I shall spare no effort to restore world trade by international economic readjustment, but the emergency at home cannot wait on that accomplishment. ” --FDR, First Inaugural (1933) 28

Even with the election of FDR in 1932, the US still saw restoring world trade as secondary to— and separate from!— reinvigorating the American economy. 27

What about the former hegemon, Britain—the birthplace of free trade? 29

II. The Interwar Collapse 1. 2. 3. • Who will take the reigns of power? The US: Smoot-Hawley Britain: Imperial Preference The Axis: Self-Sufficiency

The story in Britain is a bit complex. In short, Britain’s declining position combined with its domestic politics to initiate a major shift in its trade policy. 31

British Domestic Politics • Conservatives (Tories) increasingly support commercial management • But Liberals and Labour remain committed to free trade • Throughout the 1920 s, the Liberal-Labour coalition is able to prevent protectionism 32

The 1931 Financial Crisis • As we’ll discuss, Britain had difficulty defending the gold standard in the 1920 s • The global “slump” in 1929 made things even more difficult • In 1931, the Labour Government failed to defend sterling against attack • This initiated a decade of Tory domination 33

After winning the largest electoral victory in modern British history, the Tories pushed through extensive commercial regulation. 34

British Protectionism • Import Duties Act (1 Mar 1932) – Introduced by N Chamberlain, son of J Chamberlain – General tariff of 10% (excepting foodstuffs & raw materials) – Specific tariffs ratcheted up to as much as 33% • British Empire Economic Conference – “Ottawa” Conference; Summer 1932 – Official abandonment of gold standard – Established “imperial preference” system: 35

“Buy Empire” 36

II. The Interwar Collapse 1. 2. 3. 4. Who will take the reigns of power? The US: Smoot-Hawley Britain: Imperial Preference The Axis: Self-Sufficiency

The Treaty of Versailles (1919) unequivocally established the subordination of Germany’s economy to the welfare of the allied powers. 38

The global economic slowdown hit Germany particularly hard. When unemployment rates rose above 30% in 1933, Hitler ascended to power, largely on a platform of reversing the effects of Versailles. 39

Germany’s foreign economic policy was carefully managed first by Hjalmar Schacht and later by Hermann Goering. 40

Nazi Germany’s FEP • Money – Abandoned Fixed Exchange Rate – Heavy capital controls, restrictions on “foreign” ownership • Trade – Heavily managed; high restrictions – Creation of German trading bloc 41

Imperial Japan’s FEP • In 1930 s, Japan relied heavily on trade— particularly with US for oil (~80%) • Second Sino-Japanese War (1937 -1945) – After WWI, Japan took Germany’s sphere of influence in China – Chinese resistance prompted crackdown • July 1941: US imposed oil embargo • Japan became more deeply committed to self-sufficiency 42

Agenda: Interwar Trade Policy I. The Global Trade Regime before WWI II. The Interwar Collapse III. Reconstructing the Global Trade Regime • Conclusions & Further Questions 43

The first stepping stone back to liberalization was placed by the US with the 1934 Reciprocal Trade Agreements Act (RTAA). 44

The RTAA • Enacted 12 June 1934 • Transfers power of setting tariffs from Congress to President • Major provisions – Bilateral negotiations for reciprocal reductions – Tariff reductions up to 50% – Continued most-favored-nation (MFN) practice 45

2 Key Questions about the RTAA 1. How do we explain the passage of the RTAA 2. How do we explain its durability? 46

III. Reconstructing the Global Trade Regime 1. Bailey, Goldstein, & Weingast: Institutions 2. Hiscox: War 3. Implications

Previous Explanations of RTAA Explanation Problems 48

Previous Explanations of RTAA Explanation Problems Lazy Congress Possible to Do Nothing; Easier ways to streamline without abdicating authority Lesson Thesis: Policy-makers Counter-intuitive; Partisan learned lesson from Smoot- Voting Hawley New Agenda-Setting Authority for President; Part of Larger Expansion of Presidential Power Insufficient; Doesn’t explain shift in Congress’s preferences 49

What is the key variable that BGW suggest explains the shift in American trade policy? 50

BGW emphasize change in institutions. (309) But that doesn’t mean that institutions matter more than ideas & interests. 51

What are the key institutional features according to BGW? 52

BGW: Key Institutional Features • Power to the President – – • Satisfying Congress with Reciprocity – – – • Broader district preference for more liberalization Presidents stop logrolling (like “line item veto”) Reciprocity created export opportunities Now: Broadened Range of Acceptable Tariff Cuts Later: Exporters become entrenched advocates of liberalization Conclusion: RTAA jumpstarted export industry which never looked back 53

III. Reconstructing the Global Trade Regime 1. Bailey, Goldstein, & Weingast: Institutions 2. Hiscox: War • Implications

So, that’s our explanation of the US move towards trade liberalization between 1930 and 1945? -- The RTAA nurtured exportoriented industry. Um…Aren’t we forgetting something? 55

SAINT PAUL’S, LONDON 56

STALINGRAD 57

DRESDEN 58

TOKYO 59

Hiscox: Let’s not underestimate the extent to which the complete evisceration of foreign industrial capacity created export markets that the US wanted to ensure remained open! 60

“These changes reflected the dramatic, exogenous effects of World War II on U. S. export and import-competing industries as well as longer-term shifts in U. S. comparative advantage and in party constituencies. In this alternative account of the RTAA and U. S. trade liberalization, the historical coincidence of several profound economic and political changes are central to the eventual outcome. ” (670) 61

III. Reconstructing the Global Trade Regime 1. Bailey, Goldstein, & Weingast: Institutions 2. Hiscox: War 3. Implications

What are the implications of these differing interpretations? 63

BGW: Institutions Matter • Let’s build institutions • The institutional design matters 64

Hiscox • Let’s not spin our wheels about institutions • Underlying economic variables really matter. Let’s focus on those. Maybe then we can at least see what’s coming. “The dismal conclusion is that, if policy is settled in a protectionist equilibrium (that is, reform is needed), it is unlikely that a simple change in the policymaking rules will also be possible or sustainable for long in the absence of some serendipitous change in actor preferences”. 65 (690)

Agenda: Interwar Trade Policy I. The Global Trade Regime before WWI II. The Interwar Collapse III. Reconstructing the Global Trade Regime IV. Conclusions & Further Questions 66

Key Insights about Trade Policy • Interest Groups… – Must be understood narrowly (not just “agriculture”) (BE) – Form, dissolve, & reform flexible coalitions (BE) – Shape policy; and are shaped by policy (BGW) • Trade policy is formulated in context of other policies (e. g. unemployment policy) (JMK) • Exogenous variables (like war) still matter (MH) • Institutions might matter as well – They shape channels through which interests exert pressure (BGW) 67

Questions • The obvious question: what should be our ideal trade policy? • Less obvious but equally important – Where should trade policy stack up in preference hierarchies? Should trade policy be subordinate to other policy goals? – Once we determine the trade policy we want, how do we go about securing it? 68